September 2000 Fraser Forum: Winners & Losers from the Prozac™ Patent Decision

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John R. Graham

On August 9, an American court shook up the pharmaceutical business by striking down a patent on Prozac™. Prozac™ is probably the world’s best known anti-depressant drug. Popularized by books such as Listening to Prozac and Prozac Nation, and condemned by other books including Prozac Backlash and Potatoes, Not Prozac, it is unlikely that many adults in Canada and the United States do not have at least a passing familiarity with the drug.

Prozac™ has two patents in the US: one which expires in February 2001, and one which expires in December 2003. Patents are tools of intellectual property protection which governments grant in order to foster innovation. Potential competitors are not allowed to launch copies of the patented product without permission of the patent-holder. Supporters of the patent system believe that this temporary monopoly motivates innovative firms to invest in developing new products. The question remains: How much protection should these innovative firms be granted before the protection is so great that it stifles competition to society’s detriment? The recent Prozac™ decision provides an interesting case study to assess this issue.

In the pharmaceutical market, competition is provided by generic manufacturers who make their own versions of innovators’ drugs once their patents expire. In this case, the court decided that the December 2003 Prozac™ patent had been wrongfully granted, in that it was not significantly different from the February 2001 patent. This decision means that generic copies of the drug can be introduced 34 months earlier than had previously been expected. The waters are a little muddied by the fact that Eli Lilly & Co., Prozac’s™ patent-holder, has applied to the US Food and Drug Agency for paediatric exclusivity. This means that if the FDA determines that the drug has paediatric value, its protection is extended for a further six months from February 2001, that is, until August 2001. In this case, competitors will introduce generic fluoxetine HCL¹ 28 months earlier that had been expected.

American consumers of Prozac™ are expected to benefit from this reduction in the patent term because generic fluoxetine HCL will be sold for a significantly lower price than Prozac™. How much will consumers benefit? This is a challenging question to answer, but made easier by the fact that in Canada Prozac™ has been subject to generic competition since 1996, when the drug’s Canadian patent expired. In Canada, sales of fluoxetine HCL were Can$96 million in 1999.² Of this, almost Can$14 million (14 percent) were Prozac™ and about Can$82 million (86 percent) were generic versions. Three generic manufacturers comprise 91 percent of the generic market for this drug. As is usual in the pharmaceutical market, there is a large price difference between Prozac™ and generic fluoxetine HCL. For 30 tablets of 20 mg dose, the retail price (including the pharmacist’s dispensing fee) of Prozac™ is Can$65.58; for generic versions it is $42.83 (a price ratio of 1.53).³

In the US, where no generic competition yet exists, sales of Prozac™ for the 12 months ending June 2000 were US$2.6 billion. The retail price for thirty tablets of the 20 mg dose is US$72.67.⁴ Let us assume that some time after Prozac’s™ patent expires, the price ratio of Prozac™ to generic fluoxetine HCL will be the same as it is currently in Canada, 1.53. However, we are not immediately concerned with this long-run equilibrium, but the situation arising from the shortened period of patent protection. It is not yet known whether the FDA will grant Prozac™ six months of paediatric exclusivity. Let us assume that there is a 50 percent chance that Eli Lilly wins this protection. This means that there is a 50 percent chance that generic fluoxetine HCL will enter the market 28 months earlier than had been expected, and a 50 percent chance that it will enter 34 months earlier. To simplify our calculations, we will split the difference and assume that generic entry will occur 31 months earlier than previously expected, in May 2001.

Not all generic competitors enter the market at the same time. Indeed, in the US, the first generic entrant enjoys exclusivity in the generic market for 180 days. This is to give a margin of advantage to the first mover. It is known that Barr Laboratories is the generic company ready to supply the first generic version. Thus, Barr’s fluoxetine HCL will be the only competitor to Prozac™ from May to November 2001, whereupon further generic competitors are free to supply their versions of the drug.

Now comes the hard part: estimating the prices and market shares of the generic competitors during the period of interest, May 2001 to December 2003. Let us assume that Barr’s fluoxetine HCL enters at a price which is 70 percent of Prozac’s™ price.⁵ Further, let us assume that it immediately captures 50 percent of the US market, a market share which remains stable for 6 months until November 2001. Therefore, total savings to consumers (all calculations in US dollars) for this period will be:

(6/12) x $2.6 billion x 0.3 x 0.5 =
$19.5 million

However, we must also ask whether new customers will demand generic fluoxetine HCL who were not previously willing to pay for Prozac™. For example, patients who currently use other generic anti-depressants, such as trazedone HCL, may ask their doctors for the new drug. Unfortunately, estimating this substitution effect is extremely difficult, so we will make the assumption that users of other generic anti-depressants do not switch to fluoxetine HCL.

Let us counter this extremely restrictive assumption with a very liberal assumption: that the market reaches long-term equilibrium immediately after Barr’s exclusivity expires in November 2001. That is, many generic manufacturers enter the market, the generic market share reaches 86 percent, and the price ratio of Prozac™ to generic fluoxetine HCL immediately rises to 1.53, as in Canada. These conditions persist for 25 months until December 2003, when the second Prozac™ patent was due to expire. Further savings to consumers during this latter period will be:

(25/12) x $2.6 billion x (1/1.53) x 0.86 =
$3.04 billion

So, our rough estimate of savings to American consumers due to the early termination of Prozac’s™ patent protection is US$3.06 billion.⁶ That’s the good news. However, the benefit to consumers is only one side of the story: the decision will also effect the earnings of the suppliers to the market. For example, Eli Lilly & Co. is obviously a loser and Barr Laboratories is a winner from the judgement. Fortunately, we can observe the amount by which suppliers won and lost from this event without having to make the assumptions necessary to estimate benefits to consumers. Since the relevant companies trade on stock markets, investors were able to assess the effects of the decision immediately. Thus, share prices of the companies involved quickly changed to reflect the market’s new view of their future earnings.

Unsurprisingly, Eli Lilly & Co was punished harshly on August 9, with a share price drop of 31 percent. Barr Laboratories was rewarded with a rally of similar proportions. However, Eli Lilly is a much larger company than Barr, so the loss of value on Eli Lilly of more than US$35 billion is not compensated by Barr’s increase in value of $34 million. The negative effects of the Prozac™ decision affected other companies as well. According to reports in the Wall Street Journal that day, the uncertainty of the value of patent protection caused many innovative pharmaceutical companies to lose value that day, especially those involved with developing successors to Prozac™. The newspaper did not note that any generic manufacturers other than Barr enjoyed a share price rally as a result of the decision. The net change in wealth due to these share price changes is shown in table 1, arranged alphabetically:⁷

Only one company, Barr, benefited from the decision. All of the other, much larger, research-based companies suffered. The largest companies, Pfizer, SmithKline Beecham, and Glaxo Wellcome, who have nothing directly to do with Prozac™, contributed most to a total loss of wealth of almost US$69 billion. Such was the damage to investors’ confidence in the value of the intellectual property of these companies.

The Prozac™ case gives an indication of the value of patent protection to the economy. The striking down of less than three years of patent protection gave consumers savings of about $US3 billion, while costing shareholders almost US$69 billion: a net loss of more than US$66 billion.⁸ What is the meaning of this loss? It signifies that investors (a group that includes many pharmaceutical consumers, especially the elderly) have lost a significant amount of confidence in the ability of innovative drug companies to develop new drugs for the benefit of patients, and are less willing to give money to these R&D efforts. It is too high a price to pay for a few months of price relief on Prozac™.

Notes

¹The chemical name for Prozac™ is fluoxetine hydrochloride (HCL), and generic versions of it will generally be referred to by that name.

²All sales figures are courtesy of Ms. Sue Cavallucci of IMS Health Canada.

³Author’s telephone call to a pharmacy in Vancouver, BC.

⁴Costco Online pharmacy.

⁵Estimates of these dynamics are derived from Frank, Richard G., and David S. Salkever, “Generic Entry and the Pricing of Pharmaceuticals,” Journal of Economics and Management Strategy, vol. 6, no. 1, Spring 1997, pp. 75-90.

⁶In the interests of simplicity, the author has not discounted these consumers’ benefits to their net present value.  Thus, comparing them to the changes in stock price, which are net present values by definition, lacks rigour.  However, since the net present value of the consumers’ benefits is less than the non-discounted nominal value, the figure of $3 billion is overstated, thus supporting the author’s conclusion.

⁷Only stocks which the Prozac™ decision caused to move more than 1 percent are included.  The Dow Jones Industrial Index moved less than 1 percent on August 9, so the price changes of these stocks are mostly due to the judgment, not a broad market movement.

⁸Although, as previously noted, the benefit figure of $3 billion is an understatement (as it omits the value to consumers from substitution to Prozac™), it is unlikely that the true figure reaches $69 billion.

John R. Graham (johng@fraserinstitute.ca) is Senior Analyst and Acting Director of the Pharmaceutical Policy Research Centre at the Fraser Institute. He earned his B.A. (Hons) in Economics and Commerce at the Royal Military College of Canada and his MBA at the London Business School, University of London.

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